In the United States, a parent can start a special college savings plan to save money for their children’s education. Most people refer to these saving plans as “529 plans”. 529 stands for the Internal Revenue Code law that creates the plans and governs their tax treatment.
529 college savings plans are special savings accounts. Each state has picked an administrator that oversees the accounts. To open an account in California, you have to work with the administrator the state uses. You can choose to open an account in another state, but you may have tax consequences if you are a California resident.
After you set up an account with the administrator, you can start transferring money to the account. The total amount of your contributions should not exceed the amount you will need to pay the educational expenses for your child. Of course, with the cost of a college education these days you may be able to contribute quite a bit of money. The 529 savings plan acts like an investment account, so once you contribute money to the plan, you can invest that money in mutual funds, stocks, and other investment vehicles. Using investment vehicles will generate more earnings than just leaving the money to gather interest.
529 savings plans give you substantial tax advantages. Any gain that your contributions to the 529 plan earn from being invested is tax-free. Of course, you still pay income tax on money you earn even if you later transfer that money into a 529 account. But interest or gains from the money in the 529 account does not get taxed when you remove money from the account to pay for college.
When you do withdraw money from a 529 account, you must use it to pay for your child’s tuition, room and board, or other college expenses. If you withdraw money early because of an emergency and use it for something other than college, you pay income tax on the gains and a 10% penalty. As a result, only put money in the account that you will not need for your usual expenses before your child pursues his or her education.
One of the new federal tax laws allows you to use money saved in a 529 plan for tuition at elementary, middle, or high schools, not just at colleges or universities. These schools can be public, private, or religious. You can use up to $10,000 per year from an account on your child’s secondary education. These distributions are tax-free, just like they are if you use the money for college.
Wondering about estate planning options to help your family in the future? Look to Janet Brewer, Esq. for thorough and thoughtful estate planning advice. Janet’s more than 20 years of legal experience and her certification as a California estate planning and probate specialist by the California State Bar Board of Legal Specialization will give you confidence and peace of mind. To schedule a “Get Acquainted” meeting, visit Janet's website or call her office at (650) 469-8206.